[Reprinted by permission of Kluwer Academic
Publishers. This text is based on the
version on my hard disk, so may vary in detail from the published
chapter.]

Should Medicine be a Commodity?

An Economist's Perspective

In our society, probably in any society, goods are
produced and allocated in several different ways. One very common
pattern is production for and sale on the market. Butter, computers,
and plumbers' services, to take three examples out of a multitude,
are produced by individuals and firms, acting in what they perceive
to be their own interest, and sold, usually for money, to those who
wish to consume them. While this is a common way in which goods are
produced and allocated in our society, it is not the only way, nor is
it even clear that it represents a larger part of the total economy
than alternative ways.

What are the alternatives? The two most important
are household production--the way in which children are reared, homes
cleaned, clothes washed, and most meals cooked--and political
production. While household production represents a substantial
fraction of the economy, and perhaps even of total medical services
(parents serving as nurses for their sick children, grown children
taking care of aging parents, and the like), its role is not at the
moment a subject of much controversy and will be ignored in this
essay. The two alternatives I will be concerned with are production
and allocation on the market and production and allocation by
government. The essential question I will try to answer is whether
one form of production should be preferred, and if so which.

The meaning of market provision of medical
services is fairly clear, although the form may vary; individual
physicians, group practices, private hospitals, payment by
individuals or by insurance companies, are all possible market
arrangements. The meaning of governmental provision is a little less
clear. For the purposes of this essay I include three different sorts
of government intervention under the general category of government
provision and allocation--production, payment, and regulation. An
obvious example of governmental production of medical services is a
state hospital, or, on a larger scale, the British National Health
System. Government payment would include systems such as medicare,
where the service is produced on the market but paid for, in whole or
in part, by government. Regulation includes such widely accepted
activities as licensing of physicians and control by the FDA over the
introduction of new drugs.

While it is convenient to speak of government as
if it were an independent being, it is also highly misleading. As
should become clear in Part II of this chapter, I regard government
not as some outside force accomplishing its own good or evil
objectives but as a shorthand description for a mechanism--a set of
rules--under which individuals interact in order to achieve
individual objectives. From this standpoint, calling the alternatives
"market" and "government" is itself somewhat misleading, since
government can be viewed as merely a second and different market, a
political market in which exchanges occur and decisions are made
under a different set of rules than in the economic market. The
question then is whether it is better for medical services to be
produced entirely in the private market--what I mean by medicine
being a commodity--or entirely in the public market, or by some
combination of the two.

In trying to answer this question I will start, in
Part I, by discussing the relation between economic analysis and
normative conclusions. Doing so will involve an unavoidably lengthy
discussion of what economists mean by efficiency and what, if
anything, it has to do with conclusions about what should happen. I
will go on, in Part II, to discuss what economics can tell us about
the relative efficiency of the economic and political market. In Part
III I discuss, first, some general criticisms of the economic
approach, and then several arguments that suggest that medical care
is, in some fundamental way, a different sort of good, so that the
ordinary economic arguments used to discuss how butter or automobiles
can best be produced are irrelevant to the production of medical
care. In Part IV I discuss arguments that treat medical care as an
ordinary good but claim that it, like some other goods, has special
characteristics that justify producing it partly or entirely through
the political market. In Part V I will attempt to summarize my
conclusions.

I. Apologia Pro Via Sua--A Philosophical
Introduction

The purpose of this essay is to discuss, from the
viewpoint of an economist, the arguments against use--or at least,
against exclusive use--of the market in health care. This section
deals with the relation between the philosophical question of what is
desirable and the economic question of what is efficient. Part II
will be concerned with the economic and philosophical question of
whether we have any basis for judging whether the efficiency of
particular market arrangements is likely to be increased or decreased
by governmental interventions.

Economic efficiency is not a self-evident goal;
most people who clearly understand what it means would agree that
there are some circumstances in which an inefficient outcome is
preferable to an efficient one. Arguments based on efficiency
therefor depend on further moral arguments. I will spend much of this
paper--almost all of Parts II and IV-- discussing the case for and
against the market in terms of economic efficiency; the purpose of
this part of the essay is to explain why.

Before doing so it seems only fair to describe, at
least briefly, my own position on moral philosophy, in order to help
the reader make proper allowances for the biases of the author. This
is particularly important since, for reasons shortly to be explained,
my views may not be obvious from the arguments I will be
using.

The position in moral philosophy that I find least
unsatisfactory is that there exist natural rights, that they can be
described in terms of entitlements, and that to be entitled to
something is not the same thing as to deserve it. Seen from this
position, entitlements may not be a complete statement of what I
ought to do, but they are a complete statement of my claims against
others and theirs against me--what each of us may properly compel the
other to do. My position is in this regard similar to that defended
by Robert Nozick in Anarchy, State and
Utopia.

The rules of original entitlement and transfer
that I find plausible correspond fairly closely to the laws of a pure
free market society. In the course of this article I will argue that
those rules have other attractive features--that the same
institutions I consider morally attractive also approximate a
utilitarian optimum more nearly than any alternative I know. One
should perhaps be suspicious of such a convenient coincidence. One
explanation of it is that I am, consciously or unconsciously,
distorting and selecting economic arguments in order to justify as
efficient institutions I support for other reasons. A second is that
I am, consciously or unconsciously, distorting my moral philosophy to
justify institutions that I support because they are efficient. A
third--and the most interesting--is that the "coincidence" reflects
some underlying connection between natural rights and utilitarian
arguments.

What is Efficiency Anyway?

The conventional definition of economic
efficiency, due to Pareto, is that a Pareto-improvement is a change
that benefits someone and injures no one and a situation is efficient
if it cannot be Pareto-improved. The rule for judgment that this
seems to suggest--reject all inefficient outcomes--is less value-free
than it at first appears. I therefore prefer to use a slightly
different approach, due to Marshall. I define an improvement as a
change such that the total benefit to the gainers, measured by the
sum of the numbers of dollars each would, if necessary, pay for the
benefit, is larger than the total loss to the losers, similarly
measured. I call this a Marshall improvement. I define a situation as
efficient if it cannot be Marshall-improved.

While my definition of an improvement is not
equivalent to the conventional definition, my definition of efficient
is; a situation that is Pareto efficient is also Marshall efficient,
and vice versa.[1] To see why, we must look a little more carefully at the
word "can" in the definition of efficient; what does it mean to say
that a situation "can be improved?"

A determinist would argue that nothing can be
except what is; in this sense whatever occurs must be
efficient.[2] More generally, how strong or weak a requirement
efficiency is depends on how wide a range of alternatives we think of
as possible. In practice, economists have defined efficiency using
"can be improved" to mean "could be improved by a central planner who
had complete economic knowledge and complete control over individual
behavior." This represents a sort of outer bound on the outcomes that
could actually be produced by varying economic arrangements. It is
hard to see how any economic institutions could produce outcomes that
could not be produced by such a "bureaucrat god" but easy to imagine
that the bureaucrat god might be able to produce outcomes that could
not be produced by any real world economic institutions--since we do
not have gods available to run our economy. So if an arrangement is
efficient there is no institutional change that can improve it; if it
is inefficient there may be one.

This very broad definition of "can be improved" is
the reason why the best available institutions may be inefficient. It
is also the reason why Pareto-efficient and Marshall-efficient are
equivalent. The proof goes as follows:

Any Pareto improvement is a Marshall improvement;
since there is at least one gainer and no losers, gains must be
larger than losses. Hence a situation that can be Pareto improved can
also be Marshall improved. Hence a situation that is Marshall
efficient (cannot be Marshall improved) is also Pareto
efficient.

Suppose there were a situation that was Pareto
efficient (could not be Pareto improved) but not Marshall efficient.
There would then be a possible Marshall improvement--a change that
would benefit the gainers by more, measured in dollars, than it would
injure the losers. A bureaucrat god could make that change and
simultaneously transfer from gainers to losers a sum larger than the
losses and less than the gains, taxing each gainer an amount less
than his gain and giving each loser an amount greater than his loss.
The combination of the Marshall improvement plus the transfer would
be a Pareto improvement. But a situation that can be Pareto improved
is not Pareto efficient--which contradicts the original assumption.
Hence any situation that is Pareto efficient is also Marshall
efficient. Hence the two definitions of efficiency are
equivalent.[3]

If the two definitions of efficiency are
equivalent, why have I bothered to introduce and use the
unconventional one? Because the conventional definition, as it is
commonly used, is a way of making interpersonal utility comparisons
while pretending not to; Marshall's approach makes the same
comparisons but is honest about what it is doing.

What justification can there be for making
interpersonal utility comparisons in a way that, by comparing gains
and losses as measured in dollars, implicitly assumes that the
utility of a dollar is the same to everyone? Marshall's answer was
that for most economic questions it does not much matter how you
weight utilities. Most issues involve large and diverse groups of
gainers and losers; unless there is some systematic tendency for one
group to have a higher marginal utility of income than another, the
differences among individuals average out, so if the utility gain to
the gainers is larger than the loss to the losers when measured in
dollars, it is probably also larger measured in utiles. Utility
measured in dollars is observable, since we can observe how much
people are willing to pay to achieve their objectives; utility
measured in utiles is not. We use the former as a proxy for the
latter. Seen in this way, judgments of efficiency are really
approximate judgments about utility. "O1 is more efficient that O2"
means "going from O2 to O1 is a Marshall improvement" means "utility
is (probably) higher in O1 than in O2." I will make a careful
distinction between efficiency and utility only in those special
cases where there is a reason to expect the approximation to be a bad
one.

Why Bother With Efficiency?

My justification for discussing the case for or
against the market in medical care in terms of economic efficiency
rests on three propositions. The first is that more is known about
economics than about moral philosophy, so we are more likely to reach
true conclusions and be able to convince others of them through the
former than through the latter. The second is that most real world
moral philosophies overlap considerably, with utilitarian
considerations an important part of the overlap. While only
utilitarians will claim that utility is all that matters, and even
utilitarians will not claim that efficiency as defined by economists
is all that matters, most people believe that utility, and efficiency
as an approximation thereof, are among the things that matter. The
third proposition is that the difference in efficiency among
different institutions is large--large enough to affect the
conclusions, with regard to those institutions, of many who are not
utilitarians. I suspect, although I cannot prove, that market
arrangements are so much superior to any workable alternative that
most people, including most non-utilitarians, would prefer their
consequences to those of any alternative.[4] If I am right, then political disagreement is
fundamentally a disagreement about the economic question of what
consequences different institutions produce, not the ethical question
of what consequences we prefer. This is in part an economic opinion
about the efficiency of the market, and in part an economic opinion
about the range of workable alternatives.

In Sum

I believe that utilitarian comparisons among the
outcomes of different institutions are neither irrelevant nor
conclusive; I view the economic concept of efficiency as the most
practical way of making such comparisons. I will therefore try to use
economics to analyze the arguments against market health care, mostly
in terms of economic efficiency.

Economics is not limited to arguments about
economic efficiency; indeed, some economists would argue that such
"welfare economics" is too much involved with issues of value to be a
real part of the science. From my viewpoint, efficiency is simply one
useful way of summing up positive results--results about the
consequences of particular institutions. It provides a convenient
compromise between the questions people ask economists and the
questions economists are equipped to answer. It is not, however, the
only thing economics can say about the outcome of institutions, hence
not the only contribution that economics can make to disputes as to
what institutions are best. I shall, to take one example, feel free
to use economic arguments not only to discuss whether government
interference with the market has a cost in decreased efficiency, but
also whether it produces any benefit in increased equality.

Part II: Is The Best the Enemy of the
Good?

Efficiency Proofs

Economic efficiency is a strong requirement for
the outcome of any real world system of institutions, since an
outcome is efficient only if it could not be improved by a bureaucrat
god--a benevolent despot with perfect information and unlimited power
over individual actions. While it may be seen as an upper bound on
how well an economic system can work, one might think that using that
bound to judge real systems is as appropriate as judging race cars by
their ability to achieve their upper bound--the speed of
light.

Surprisingly enough, it is possible to prove that
a market system that meets certain assumptions is efficient in this
strong sense. There are several sets of assumptions that will do; two
of them may be roughly stated as follows:

I. Perfect
Knowledge: Individual producers know the
cost of all alternative ways of producing and the market price for
what they produce; individual consumers know the price and the value
to them of goods they consume.

II. Private
Property: Property rights are defined and
costlessly enforced and can be costlessly transferred for all scarce
goods.

Either

III. No Transaction
Costs: Any transaction mutually
advantageous to the parties involved can be arranged at no
cost.

Or

IV. Perfect
Competition: Every producer and consumer
is so small a part of the market that the quantity he produces or
consumes does not affect the market.

V. Private
Goods: Every producer can control the use
of the goods he produces.

These assumptions are chosen to eliminate market
failures traditionally associated with the terms public goods,
externalities, imperfect competition, and imperfect or asymmetric
information. Assumption III substitutes for assumptions IV and V
because of the Coase Theorem; under conditions of zero transaction
costs all of the inefficiencies associated with imperfect
competition, externalities, and public goods can be eliminated by
appropriate bargains among the affected parties.[5]

Of course, no real world economy satisfies either
assumptions I, II, and III or I, II, IV and V exactly. This fact is
frequently used to advocate government intervention in the market, on
the grounds that it can improve the inefficient outcome due to one or
another sort of market failure. The difficulty with such arguments is
that there is no adequate theory of government behavior that implies
that government would choose to do the right things--that its
intervention would make things better rather than worse.

It is one thing to show that there is something
government could
do that would improve on the outcome of the unregulated market; it is
an entirely different, and much more difficult, thing to show that
what government would do, given the power, would improve on that outcome. That
would require a theory of governmental behavior comparable in power
and precision to the theory of market behavior from which the
original efficiency theorem, and the inefficiencies due to failures
of its assumptions, were derived. No widely accepted theory of that
sort exists, and much of the large and growing literature that
attempts to produce such a theory seems to suggest that government
intervention is more likely to worsen than to improve market
outcomes.[6]

Even if one drops the traditional argument that
every deviation of the market outcome from perfect efficiency
justifies a countervailing intervention by the state, one can still
argue that since real markets do not meet the requirements of the
efficiency theorem we can expect them to be inefficient and do not
know by how much, that since there is no efficiency theorem for the
political system we have no way of knowing how inefficient it is,
hence we have no way of guessing whether political intervention in
the market system will lead to more or less efficiency. A similar
argument on a grander scale suggests that since we have an efficiency
theorem for capitalist economies, whose assumptions real capitalist
economies do not meet, and no efficiency theorem at all for socialist
economies (or other alternative systems), we again have no basis for
predicting which is superior. By defining a perfect outcome that we
cannot achieve, we seem to have made it impossible to choose among
imperfect outcomes. The best appears to be the enemy of the
good.

This argument is, I believe, wrong for at least
three reasons. The first is that, although we do not have an economic
theory of the political process as well worked out and broadly
accepted as the theory of private markets, we do have enough of such
a theory to have some idea of where and why the political market is
likely to produce less efficient outcomes than the private market.
Second, if the situation really were that we had no theoretical basis
at all for predicting how efficient the alternatives to the market
would be, we would have some reason to expect the market to be
(imperfectly) efficient, no reason to expect its alternatives to be,
and thus a (rebuttable) presumption that the market is more efficient
than its alternatives. Third, whatever the theoretical situation may
be, there exists a large and growing body of empirical studies of the
effects of government regulation, most of which cast serious doubt on
the idea that intervention in the market is likely to lead to
improvement.

Public Choice--The Economics of the
Political Market

Conventional economics provides us with an
analysis of the economic market, including some understanding of why
and to what extent it fails to be efficient. In order to compare the
outcomes to be expected from the economic market with those to be
expected from the political market, we need some way of analyzing the
latter. There exists a body of economics called public choice theory
that attempts to analyze the political system by using the same
approach with which ordinary economics analyzes the private market.
While no single version of public choice theory is as well worked out
and widely accepted as is the conventional price theory used to
analyze ordinary private markets, public choice theory as it now
exists provides economists with some limited ability to predict where
and why political alternatives to the market will or will not be
efficient. We do not have an adequate theory, but we have something
more than no theory at all.

Public choice theory is simply economics applied
to a market with peculiar property rights. Just as in the economic
analysis of an ordinary market, individuals are assumed to rationally
pursue their separate objectives; just as in that analysis, one may
first make and later drop simplifying assumptions such as perfect
information or zero transaction costs. But the property rights on the
public market include the right of individuals to vote for
representatives, of representatives, acting through the appropriate
procedures, to make laws, of various government officials to enforce
the laws, of judges to interpret them, and so on.

Ordinary economics is greatly simplified if we
treat firms as if they were imaginary individuals trying to maximize
their profits; in this way we reduce General Motors from several
hundred thousand individuals to one. There is some cost to the
simplification, since it ignores the conflicts of interest within the
firm among managers, employees, and stockholders. So far no
alternative simplification seems to work as well, so economists
continue to analyze an economy of profit maximizing firms, except
when the particular problem being considered hinges on intra-firm
interactions--as it does, most obviously, in the theory of the
firm.

One of the ways in which different public choice
theories differ is in what they take to be the equivalent of the firm
on the political market, and what it is assumed to maximize. Downs,
one of the founders of public choice, took his unit to be the
political party.[7] Niskanen took it to be the individual government
bureau.[8] Other analyses take interest groups or politicians as the
"firms," or eliminate firms entirely and consider individual voters.
For the purposes of the following brief sketch, I will consider the
firms on the political market to be elected politicians (or,
equivalently, the political organizations of which they are a part),
and limit my discussion to the market for legislation. This is a
simplification of the political market, and only one of several
possible simplifications, but it provides a convenient way of
sketching the theory.

Consider, then, the market for legislation.
Individuals perceive that they will be benefitted or harmed by
various laws. They therefor offer payments to politicians for
supporting some laws and opposing others. The payments may take the
form of promises to vote, of cash payments to be used to finance
future election campaigns, or of (concealed) contributions to the
politician's income.[9] The politician is seeking to maximize his long run income
(plus non-pecuniary benefits, one of which may be "national
welfare"), subject to the constraint that he can only sell his
support for as long as he can keep getting reelected.

Is the outcome of this market efficient? That
depends on additional assumptions. If all transaction costs are zero,
the answer is yes. As long as there is any potential change in
legislation--any law to be passed or repealed--that confers net
benefits, there is some possible agreement that will produce the
change while benefitting all those whose cooperation is required. The
Coase theorem applies to political as well as private markets.

Even with transaction costs, we would still expect
efficient outcomes as long as the amount individuals or groups are
willing to pay for any piece of legislation is proportional to the
benefit they receive from it, with the constant of proportionality
the same for all. In that case, any law whose passage conferred net
benefits would be profitable to pass--more would be offered to
support it (by those benefitted) than to oppose it (by those
injured).

Alternatively, we might expect an efficient
outcome if we assume that all voters are perfectly informed. In that
case campaign contributions are useless, since no voter can be
persuaded to vote against his own interest, and we have civics class
democracy, with the candidate who best represents the public interest
getting elected.[10]

The important question, however, is not whether
the political market works under conditions of zero transaction costs
and perfect information; under those assumptions, the private market
is also perfectly efficient. The interesting question is how badly
each system breaks down when the assumptions are relaxed.

Consider a political market with realistic
transaction costs. A legislator proposes a bill that inefficiently
transfers income from one interest group to another; it imposes costs
of $10 each on a thousand individuals and gives benefits of $500 each
to ten individuals. What will be bid for and against the law?

The total cost to the losers is $10,000, but the
amount they will be willing to offer to a politician to oppose the
law is very much less than that. Why? Because of the public good
problem.[11] Any individual who contributes to a campaign fund to
defeat the bill is providing a public good for all the members of the
group. The same arguments that imply underproduction of public goods
by the market apply here. Just as in that case, the larger the public
the lower the fraction of the value of the good that can be raised to
pay for it.

The benefit provided to the winners is also a
public good, but it goes to a much smaller public--ten individuals
instead of a thousand. A small public can more easily organize,
through conditional contracts ("I will contribute if and only if you
do") to fund a public good. Even though the benefit to the small
group is smaller than the cost to the large one, the amount the small
group is able to offer politicians to support the bill will be more
than the amount the large group will offer to oppose it.

The effect is reinforced by a second
consideration--information costs. I now drop the assumption of
perfect information; instead, I assume that information about the
effect of legislation on any individual can be obtained, but only at
some cost in time and money. For the individual who suspects that the
bill may injure him by $10, it is not worth paying much to obtain the
information. Not only is his possible loss small, but the effect on
the probability that the bill will pass of any actions he would
consider taking is also small. The member of the dispersed interest
chooses (rationally) to be worse informed than the member of the
concentrated interest.

If we abandon the particular example and consider
the extreme case of an American presidential election, the argument
becomes even clearer. Suppose the average election is won by 2.5
million votes. We may simplify the analysis by replacing the actual
probability distribution for the outcome by a uniform probability
distribution from -5 million to +5 million. The probability that the
election will be a tie, hence that one additional vote can decide it,
is then one in ten million. So the return to an individual who
figures out who is the right candidate and votes accordingly, instead
of voting at random, is an increase by one chance in ten million of
the probability that the right candidate will be elected. Unless the
voter has an extraordinarily high value for electing the right
candidate, it is not worth paying very much in order to increase the
probability of that outcome by one in ten million, so he does not pay
the information costs necessary to decide for whom he should vote.
This is rational ignorance. It is rational to be ignorant if the cost
of information is greater than its value.

So far I have discussed only one characteristic of
a group--its size. It is useful to think of the terms "concentrated"
and "dispersed" as proxies for the set of characteristics that
determine how easily a group can fund a public good for that group;
the number of individuals in the group is only one of those
characteristics.

Consider, for example, a tariff on automobiles. It
benefits hundreds of thousands of people--stockholders in auto
companies, auto workers, property owners in Detroit, and so forth.
But General Motors, Ford, Chrysler, American Motors, and the UAW are
organizations that already exist to serve the interests of large
parts of that large group of people. For many purposes one can
consider all of the stockholders and most of the workers as "being"
five individuals--a group small enough to organize effectively. The
beneficiaries of auto tariffs are a much more concentrated interest
than a mere count of their numbers would suggest. That may explain
why such tariffs exist, even though they are inefficient--the costs
they impose on consumers of automobiles and American producers of
export goods (both dispersed interests) are larger than the benefits
to the producers of automobiles.

The reason the public good problem leads to
inefficiency on ordinary private markets is that the amount a group
can raise to buy a public good benefitting that group is less than
the total value of the good to the members of the group, hence some
public goods that are worth more than they cost to produce fail to
get produced, which is inefficient. The problem on public markets is
that both costs and benefits are only fractionally represented on the
market, due to the public good problem--and if the weights are
different, as they almost always will be, laws that impose net costs
may be passed and laws that impose net benefits may not be. This
again is inefficient.

To compare the efficiency of the two systems--the
private and the political market--we must specify the degree of
publicness of the good and the nature of the publics involved. If,
for example, we consider the private production of a pure public good
for which the public is the entire population of the country, the
political alternative may be an attractive one. The private market
will produce the good only if total benefit times the weighting
factor relevant to that public (the percent of the benefit that can
be raised to pay for the good) is larger than the cost of producing
the good. The public market will produce the good only if total
benefit times the weighting factor (the same as before) is larger
than total cost times a weighting factor representing the fraction of
the tax money saved by not producing the good that taxpayers (also a
public with a public good problem) can raise to oppose its
production. Since the weighting of cost as well as of benefit is
(much) less than one, the chance that weighted benefit is greater
than weighted cost (so that the good will be produced politically) is
greater than the chance that weighted benefit is greater than
unweighted cost (so that it will be produced privately). The public
good is more likely to be produced publicly than privately.

This is not entirely a good thing. If the
weighting factor on cost is smaller than on benefit--if taxpayers are
a more dispersed interest than beneficiaries, as they would be if the
good benefitted only a small group--then the good may be produced
even if cost is greater than benefit. This too is inefficient,
although in the opposite direction--producing a good that should not
be produced rather than not producing one that should.

In many cases, although perhaps not in the case of
defense, the size of the public and the degree of publicness are
quite different on the private and political markets. Consider
immunization against contagious disease. Immunization is only partly
a public good; if I have myself immunized I receive a private benefit
(I am safe from the disease) and confer a benefit on others (they
cannot catch it from me). If the public and private parts happen to
be of equal value, I will choose to get immunized as long as the
total benefit is at least twice the total cost. Private immunization
is then only "half public."[12]

Suppose we decide to provide immunization publicly
instead of privately. This does not mean that we decide to provide it
if and only if it is worth providing--systems that automatically
generate right answers are not one of the options available to us. It
means rather that we have a system in which what immunizations are
given to whom--and who pays for them--are decided politically. The
decision is determined by a tug of war between two interests--those
benefitted and those paying--both large groups whose political
efforts are restricted by the public good problem. The groups would
have to be very well balanced indeed in order to generate a more
efficient outcome than "produce if benefits are at least twice
costs"--the outcome of the private system.

This article is an essay on the role of the market
in medical care, not a textbook on public choice theory. I have tried
to sketch enough of the theory to show the reader why the efficiency
of the public market generally breaks down much faster as we weaken
our simplifying assumptions (perfect information and zero transaction
costs) than does the efficiency of the private market. On the private
market, an individual who pays for information gets the benefit of
the information; if I spend time and energy deciding what car to buy,
my conclusion will determine what car I get. On the public market,
gathering information typically involves producing a public good for
a large public; if I gather information on which politician to vote
for, the result is a miniscule increase in the probability that I
(and everyone else) will get that politician and the legislation he
supports. Hence we may expect people to be much better informed about
their private than their public decisions--a conclusion that seems
consistent with casual observation. Imperfect information, while a
problem for both markets, is a much more serious problem for the
public market.

Similarly with the set of problems associated with
public goods and externalities. The typical good produced on the
private market is a mostly private good--an office building that
provides $50,000,000 worth of benefit to the individuals renting
space in it, plus a $1,000,000 benefit spread among all the
inhabitants of the city whose skyline it ornaments. If expensive
buildings strike you as a bad example, substitute my front yard
(mowed) or your neighbor's phonograph (a negative externality if you
have sufficiently different tastes in music--or in when you wish to
listen to it). Exceptional cases are pure or almost pure public goods
(scientific research of a non-patentable nature, the invention of the
supermarket) or goods for which external costs are a large fraction
of all costs. In the normal case we have something close to an
efficient outcome--the building is constructed as long as benefit is
at least 1.02 times cost. Inefficient outcomes are unlikely to occur,
and if they do occur the inefficiency is small--the failure to
produce something that is worth slightly more than it would cost to
produce, or the production of something worth slightly less than it
costs to produce. Only in the exceptional cases is inefficiency
likely to be a serious problem

On the public market, on the other hand, public
goods with large publics and goods whose costs or benefits are mostly
external are the rule rather than the exception. When I support a
bill to benefit me at your expense, all of the cost of what I am
getting is external--imposed on you and ignored in my calculations.
When a politician tries to pass a good law, he is attempting to
produce a public good with a very large public. He would almost
certainly be better off, from his own standpoint, using the same tax
money to buy the votes (or bribes) of some concentrated interest
instead. Even if the politician has a public spirited desire to pass
good laws, he will find that unless he is very rich he cannot afford
to--just as a capitalist cannot afford to give his customers what he
thinks they should have instead of what they are willing to pay for.
Unless the politician has large political assets that his competitors
lack, his attempt to do good will result in his defeat by someone who
follows a more nearly vote maximizing policy.

The conclusion of this analysis seems to be that
the public market is preferable to the private one, at most, only in
cases of extreme market failure. As long as the private market is
anywhere close to efficient, it is probably preferable to the
political alternative.

How good are our reasons for believing that the
analysis I have sketched accurately describes the real world? There
is some evidence, but it is not conclusive. The observed outcomes of
the political system--what industries get tariffs, how professions
come to be regulated, and the like--appear to fit the patterns
suggested by the analysis, but neither the evidence nor the theory is
sufficiently good to make us as confident about the economic theory
of government as we are about the economic theory of ordinary
markets.[13]

Evidence

This brings me to my third reason for believing
that the market is typically more efficient than its alternatives.
There now exists a substantial and growing body of studies of the
effects of government regulation. The conclusions suggested by many
of these studies are that regulation rarely achieves its stated
purpose, that it frequently imposes serious costs, and that it
frequently serves as an indirect way of transferring income from one
group to another.

Consider, for example, Linneman's study of the
effects of minimum wage legislation.[14] The minimum wage is often defended as a way of helping low
income workers by raising their wages. Linneman obtained, for a large
sample of individuals, data on employment, wages, and a variety of
characteristics (such as age, education, and race) that might be
expected to affect employment. Using data from before and after a
large increase in the minimum wage rate, he estimated the effect of
the increase on the wage rate and employment of the individuals in
his sample. He concluded that the effect had been to lower the
earnings of the subminimum population--the workers who would have
made less than the new minimum wage--and increase the earnings of
high wage and union workers. In effect, the increase priced unskilled
labor out of the market, increasing the demand for skilled
labor.

Consider, as a second example, Peltzman's study of
the effects of the Kefauver amendments to the Pure Food and Drug
Act.[15] The stated purpose of the amendments was to force drug
companies to demonstrate the effectiveness of "New Chemical Entities"
before putting them on the market; the argument was that because of
imperfect information, consumers paid unnecessarily to buy, and drug
companies to produce, new drugs that were no better than the old
drugs. Peltzman showed that the effect of the amendment was to reduce
the rate of introduction of NCE's by more than half without any
detectable improvement in their average quality; he estimated that
the effect was equivalent to imposing a ten percent sales tax on all
consumption of drugs.

The point of these examples is not merely to show
that the best laid plans of mice, men, and legislators gang aft
agley. It is rather to suggest that insofar as we have evidence on
the effect of intervention, the evidence is that the intervention
imposes net costs, and does so without achieving the
objectives--sometimes involving efficiency and sometimes not--for
which it purports to exist. It is further to suggest that the
observed pattern is more consistent with rational behavior aimed at
objectives other than those announced than it is with the other
obvious explanation--repeated error. In the case of the minimum wage,
for instance, it is worth noting that the congressmen supporting it
have generally represented high wage, not low wage, states and
industries.

In summary, then, the conclusion of this section
of the paper is that both economic theory and empirical studies
provide a basis for preferring market to political arrangements
except, perhaps, in cases of extreme market failure. The conclusion
does not have the rigor of a mathematical theorem--but neither, so
far as I know, does any conclusion about the real world, even in the
most precise of sciences. In addition to the uncertainty associated
with any attempt to apply a theoretical construct to a real-world
situation, the conclusion has the additional uncertainty associated
with a body of theory--public choice--that is still developing and
many of whose elements are still matters of dispute.

Part III: The Case Against
Economics

In Part I of this paper, I attempted to deal with
general philosophical arguments concerning the appropriateness of
economic efficiency as a criterion for judging alternative
arrangements; in Part II I tried to show how one might judge the
relative efficiency of the market and its alternatives. In Part IV I
will try to apply that analysis to the question of how medical care
should be produced and distributed.

Before doing so, there are several potential
objections to this approach that I would like to try to deal with.
Some are objections to the economic approach in general, some
objections to its application to medical care. There is little point
in my subjecting you to a lengthy economic analysis of the efficiency
of providing medical care in various ways, without first making some
attempt to persuade you that economic analysis is a legitimate way of
learning things and that its conclusions are relevant to questions of
the provision of medical care.

I will start by discussing three objections to the
economic approach that are, I think, widely held. They are, first,
that economic analysis depends on the unrealistic assumption of
individual rationality, second, that economic efficiency fails to
take account of the fact that money, which it uses as its measure of
value, is of different value to different people, and third that it
ignores the infinite value of life relative to money or material
goods, and the fact that medical care, like food, is necessary for
life. I will go on to discuss the claim that medical care has some
sort of special moral status, making it a "priority good" or implying
that people have a "right to medical care."

Rationality

The central assumption of economics is
rationality--that people have objectives and tend to choose the
correct way of achieving them. While the assumption can be modified
to deal with information costs, individuals are still assumed to make
the correct decision, in an uncertain environment, about how much
information to buy.

The use of the term "rationality" to describe this
central economic assumption is somewhat deceptive, since it suggests
that people find the correct way to achieve their objectives by
rational analysis--using formal logic to deduce conclusions from
assumptions, analyzing evidence, and so forth. No such assumption
about how people find the correct means to achieve their ends is
necessary.

One can imagine a variety of other explanations
for rational behavior. To take a trivial example, most of our
objectives require that we eat occasionally, so as not to die of
hunger (exception--if my objective is to be fertilizer). Whether or
not people have deduced this fact by logical analysis, those who do
not choose to eat are not around to have their behavior analyzed by
economists. More generally, evolution may produce people (and other
animals) who act rationally without knowing why. The same result may
be produced by a process of trial and error. If you walk to work
every day you may by experiment find the shortest route, even if you
do not know enough geometry to calculate it. "Rationality" does not
mean a particular way of thinking but a tendency to get the right
answer, and it may be the result of many things other than
thinking.

Half of the assumption is that people tend to
reach correct conclusions; the other half is that people have
objectives. In order to do much with economics, one must strengthen
this part of the assumption somewhat by assuming that people have
reasonably simple objectives. The reason for this additional
assumption is that if one has no idea at all about what people's
objectives are, it is impossible to make any prediction about what
they will do. Any behavior, however peculiar, can be explained by
assuming that that behavior was itself the person's objective (why
did I stand on my head on the table while holding a burning thousand
dollar bill between my toes? Because I wanted to stand on my head on
the table while holding a burning thousand dollar bill between my
toes).

This element in economic theory may be partly
responsible for the idea that economists assume that "all anyone is
interested in is money." Put in that way the assertion is wrong;
economists usually assume that people desire money only as a means to
other objectives. What is true is that although economics can, in
principle, take account of the full richness of human objectives, it
is necessary for many practical purposes to assume away all save the
most obvious--the consumption of goods, leisure, security, and the
like.

Economics is based on the assumption that people
have reasonably simple objectives and choose the correct means to
achieve them. Both halves of the assumption are false; people
sometimes have very complicated objectives and they sometimes make
mistakes. Why then is the assumption useful?

Suppose we know someone's objective, and also know
that half the time he correctly figures out how to achieve it and
half the time he acts at random. Since there is usually only one
right way of doing things (or perhaps a few) but very many wrong
ways, the rational behavior can be predicted but the irrational
behavior cannot. If we predict his behavior on the assumption that he
is always rational we will be right half the time; if we assume he is
irrational we will almost never be right, since we still have to
guess which irrational thing he will do. We are better off assuming
he is rational and recognizing that we will sometimes be wrong. To
put the argument more generally, the tendency to be rational is the
consistent and hence predictable element in human behavior. The only
alternative to assuming rationality (other than giving up and
concluding that human behavior cannot be understood and predicted)
would be a theory of irrational behavior, a theory that told us not
only that someone would not always do the rational thing but also
which particular irrational thing he would do. So far as I know, no
satisfactory theory of that sort exists. As I argued in Part II of
the essay, it takes a theory to beat a theory; until some better
alternative is found, rationality is the best we have.

One possible response to this is that although
rationality may give us the best available theory, a theory built on
so weak a foundation is not very useful; perhaps we are better off
depending on "common sense" answers instead.

This sounds plausible, but when it comes to
analyzing a market--a complicated interacting system--"common sense"
turns out in practice to mean a poorly thought out, inconsistent, and
untested theory. If analyzing such a system were easy, economics
would be easy too. Any good economist can provide a collection of
horrible examples from casual conversation and his daily
newspaper.

Economics and the Poor

A second set of objections to the market and the
economic approach is based on the claim that neither gives proper
consideration to the implications of income inequality. This involves
two different arguments, one of which I in part agree with. The first
is that the market--and the criterion of efficiency according to
which its outcome is often judged--measures individual values in
dollars, not in intensity of feeling; since some people have fewer
dollars than others, their desires receive less attention, even if
they are as strong as, or stronger than, the desires of the more
fortunate. The second argument is that economic analysis, and the
economic defense of market outcomes, is put in terms of choice, but
that choice is irrelevant to the poor; how can one say that an
individual chooses not to have that which he cannot afford?

The first argument can be restated by going back
to my original defense of the efficiency criterion as a proxy for the
utilitarian objective of maximizing total welfare. I conceded there
that the measure of improvement used in defining efficiency
(explicitly in the Marshallian approach, implicitly in the more
convention Paretian approach) compares costs and benefits to
different individuals measured by how much money those individuals
would spend, if necessary, to get the benefit or avoid the cost. This
is equivalent to doing an interpersonal utility comparison on the
assumption that the marginal utility of a dollar is the same for
everyone.

I defended that way of defining efficiency, from a
utilitarian standpoint,[16] by arguing that the particular rule used to weight
utilities did not matter very much. Most of the decisions an
economist is interested in affect large and heterogeneous groups of
people. Unless there is some reason to expect that a particular
weighting rule favors the losers more than the gainers, or vice
versa, differences among individuals can be expected to average out
when we consider the effect on the whole group.

There are some cases in which we do have good
reason to expect that the choice of weighting rule will differently
affect the different groups. Most of us believe that people with high
incomes have, on average, a lower marginal utility of income than
people with low incomes. If so, there will be a systematic
discrepancy between efficiency and utility when we are considering
decisions that have differential impact on high and low income
people. One obvious case is the decision of whether or not to provide
free medical care (or housing, or food, or money) to the poor at the
expense of the rest of us. If we evaluate the transfer in terms of
efficiency, we conclude that what the poor get is worth at most its
cost to them (if it were worth more, they would have bought it) while
the cost to us of paying for it is at least its cost (more if there
is some cost to collecting taxes), so the transfer provides benefits
that are at most equal to the cost and almost certainly less. If we
evaluate it in terms of utility, we conclude that even if a hundred
dollars worth of medical care is worth only ninety dollars to the
poor recipient, that may well represent more utility than the hundred
and ten dollars that it costs the not-poor taxpayer.

This is the traditional utilitarian argument for
redistribution. Three things are worth noting about it. The first is
that the assumption that marginal utility of income is correlated
inversely with income, while plausible, is not necessarily true;
under some circumstances one would expect the opposite. The second is
that the argument has no special relevance to medical costs, except
to the extent that differing medical bills may be an important cause
of inequalities in the marginal utility of income among individuals;
it is a general argument for redistribution from the rich to the
poor. The third is that while the argument suggests that we should
prefer outcomes that are biased towards the poor, everything else
being equal, it does not tell us that we should favor political over
market processes. That conclusion depends on some further argument to
show that the outcome of political processes is likely to modify the
market outcome towards equality and not away from it--that the poor
can be expected to do better on the political market than on the
economic market.

I begin with the first point. The standard
argument for redistribution begins with the claim that, for a given
individual, the marginal utility of income declines as income
increases. This seems plausible in terms of introspection,
observation (of behavior under uncertainty) and theory, although one
can construct counterexamples. The next step is to claim that, absent
information about differences in individual utility functions, we
must treat each individual utility function as a random draw from the
same population, so declining marginal utility of income applies not
only to the same individual with different incomes but (on average)
to different individuals with different incomes. It follows that the
poor have, on average, a higher marginal utility for income than the
rich.

This argument assumes that there is no causal
connection running from utility function to income. That is plausible
enough if income is determined exogenously--by inheritance, or
lottery, or some other chance mechanism. It is quite implausible if
differing income is the result of differing effort. An individual who
greatly values the things that money buys will be more willing than
others to give up other goods, such as leisure, in order to get
income, so he will, on average, end up with a higher income. If
instead of assuming that different individuals have the same utility
function but different incomes we instead assumed identical
opportunities but different utility functions, we would expect income
and marginal utility of income to be positively correlated. So our
opinion about the sign of the relationship will depend very much on
our opinion about the origin of observed inequalities in
income.

This brings me to my second point. The cost of
medical services represents a large, and to a considerable extent
random, subtraction from income. Even if we believed that people with
low incomes are, on average, poor because they do not value money,
rather than that they value money because they are poor, we should
still make an exception for those who are poor because of medical
expenses. In that case at least the traditional argument seems to
hold rigorously. The income difference is the result of a random
exogenous force, so differences in utility functions should be
unrelated to differences in income net of medical expenses, so those
whose consumption of other goods is low because of their medical
expenses should have a high marginal utility of income. It follows
that the utilitarian case for transferring income to those who are
impoverished by high medical expenses is stronger than the
conventional utilitarian case for transferring income to the
poor.[17]

Is this a conclusive argument, within the
utilitarian framework, for political intervention to alter the
outcome of market provision of medical services? That depends on the
costs of such intervention--if large enough, they might outweigh the
gains. This argument is usually put in terms of the costs resulting
from the distortion of incentives introduced by both tax and
subsidy.

While this is a legitimate argument for limiting
the size of income transfers to the poor, whether for medical or
other purposes, it gives us no reason to expect that the optimal
transfer would be zero. Elsewhere I have made a different argument
that does suggest that conclusion--essentially that giving government
the power to transfer income sets off an expensive free-for-all, with
individuals expending considerable effort to ensure that they will be
the beneficiaries of transfers instead of the ones who pay for
them.[18]

There is, however, another important problem with
political redistribution. It is usually assumed without discussion
that having government intervene to redistribute in favor of the
poor, while leaving most of the rest of the system unaffected, is one
of the available alternatives. This is the same sort of assumption
made by those who argue that wherever the market outcome is
inefficient, government should step in; in both cases, government is
treated as a deus ex
machina, introduced to produce whatever
outcome we have decided is desirable. But in discussing equality,
just as in discussing efficiency, it is not enough to show that there
is something government could do that would improve on
the outcome of the market. The question is whether what government
will do will be
an improvement.[19]

Public choice theory does not give any clear
answer as to whether government, given the power to redistribute, is
likely to increase or decrease inequality, to distribute to the poor
or from them. On the one hand, votes are more evenly distributed than
income, which should tend to make the political market more
egalitarian than the private market. On the other hand, many of the
characteristics that give groups and individuals political influence
are closely related to income. Education reduces information costs,
labor skills differentiate their possessors into (relatively)
concentrated interest groups, stockholders have their interest
represented by well organized firms and skilled (hence highly paid)
workers by well organized unions, and so forth. So far as theory is
concerned, it is difficult to predict whether the political system is
more likely to transfer money down the income ladder or up.

The evidence is also unclear. There are a variety
of well publicized programs to help the poor at the expense of the
not poor--food stamps, welfare, and the like. There are also a
considerable number of government programs to help the not-poor at
(on average) the expense of the poor--state subsidies to higher
education being a notable example. Social Security, by a large margin
the biggest income transfer program in our society, has ambiguous
effects; a poor individual who works and collects for the same number
of years as a rich individual gets a somewhat better deal, but poorer
individuals, on average, start work earlier and die earlier, hence
pay for more years and collect for fewer--which may more than balance
the progressive element in the payment and benefit
schedules.[20]

The greatest weakness in the (utilitarian)
argument for government intervention, in the market for medical care
or for anything else, is that it is an argument for an outcome. It
simply assumes that government intervention will produce that
outcome. If the assumption is correct, if government intervention
results in redistribution down the income ladder with relatively
small costs, then the argument is a correct one. If government
intervention results in large costs, as I have argued elsewhere, or
if the direction of the redistribution is ambiguous or even perverse,
so that there is no gain in equality to balance the loss in
efficiency, then the argument is wrong.

So far I have been discussing the traditional
utilitarian argument for government intervention to redistribute to
the poor. There is a second, and to my mind less defensible, set of
arguments sometimes employed against the market--especially in
medical services and other "necessities." This is the claim that poor
people cannot really be said to choose poor medical care, or poor
nutrition, or whatever, since they cannot afford anything else.
Hence, it is argued, such goods should be provided to the poor,
whether or not they are able or willing to pay for them.

Insofar as this is simply a repeat of the argument
for redistribution from differing marginal utility of income, I have
already discussed it. What is disturbing about it is that the
argument seems, in practice, to be used to justify programs to
provide "necessities" to the poor, whether or not such programs are
actually redistributive--and often enough they are not.[21] Such programs, in effect, force the poor to spend their
own money on what someone else has decided they need. It seems odd to
argue that the poor family cannot afford to pay for adequate medical
care (because there will not be enough money left for food?) and
should therefore be compelled to pay for adequate medical care (and
starve?). Yet this is what a program of governmentally funded medical
care implies, unless it also redistributes. And if one is going to
redistribute, there seems no obvious reason why the subsidy to the
poor should take the form of medical care. Why not give money, and
let the poor family decide for itself what it is most important to
spend it on? The claim that the rich choose among their wants while
the poor "must" buy their "necessities" may be effective rhetoric,
but what it actually says is that choice is less relevant to large
values than to small ones, which seems peculiar.

The Value of Life

One popular and persuasive criticism of both
market provision of health care and the economic analysis thereof is
the claim that both embody a fundamental error--the failure to
realize that life is infinitely more valuable than money. Medical
care, it is argued, is not merely a want but a need. Without medical
care we may--some certainly will--die, and without life all other
values are meaningless. Hence neither willingness nor ability to pay
is relevant to who should or should not get medical care; the only
proper criterion is who needs it.

This argument embodies several errors. The first,
and least important, is the confusion between money as a thing of
value and money as a measure of value. While money is convenient in
defining economic efficiency, it is not essential--any tradable
commodity will do. The real comparison is not between life and money
but between life and other things people value--leisure, consumption
goods, education for their children, housing, et multa caetera.

But the question still remains: Is not life, and
hence medical care as (sometimes) a necessity for life, infinitely
more important than other values?

Not if we accept the behavior of ourselves and
others as evidence about our values. Anyone who both smokes and
believes the conclusions of the surgeon general's report is
deliberately trading life--an increased probability of dying of heart
disease or lung cancer--for the pleasure of smoking. Anyone who
spends time and money on anything that does not increase his life
expectancy while there remains some unexploited opportunity for an
expenditure that does--an extra visit to the doctor, a marginal
improvement in nutrition, a slightly safer car--is demonstrating that
life, while it may be valuable, is not infinitely valuable in
comparison to other things.

Perhaps we do trade life for lesser values but
should not. I know no way to prove what we should do, but the sort of
life that would be implied by that prescription does not seem very
attractive. Not only does the assumption that life is infinitely
valuable imply that we should take no avoidable risks--no sky diving,
no skiing, no skin diving--it also implies a society wholly devoted
to achieving a single goal. It is all very well to say that we need
food, or air, or housing, or medical care, but how much do we need?
In the case of medical care, at least, the level of expenditure per
capita at which additional care produces additional returns in life
expectancy is surely far above our per capita income. If so, a
society that treated life as infinitely valuable would have no
resources left to spend on anything else--including the things that,
for many of us, make life worth living.

Another argument that could be made for the
infinite value of life is based on the economist's principle of
revealed preference. Few of us would agree to be hung tomorrow in
exchange for a payment of a million dollars, or even ten billion.
Does not that imply that our value for life is very high and perhaps
infinite?

No. It proves that money is of no use to a corpse.
What is special about the situation being considered is not the high
value of what is being bought but the low value of what is being paid
with.

Consider the difference between an offer to buy
all of someone's life immediately and offers to buy half of the
remaining years, or payments for some specified probability of death.
In both cases, many more people would accept than with the first
offer--and those who would sell all their life for some price would
sell part of it for a much lower price. This is not merely
speculation; studies of wage differentials in hazardous professions
generate value of life estimates well below a million dollars. The
reason for the almost discontinuous change as we move from offering
to buy all of a life to offering to buy a fraction of it is not the
reduction by a factor of several in the amount of life we are buying
but the increase, by a much larger factor, in the amount of life
available in which to enjoy the money.[22 ]

While I have very little intellectual sympathy
with the claim that life is infinitely more important than other
goods, I have a good deal of emotional sympathy with it--it appeals
more to my moral intuition than to the ideas with which I try to make
sense out of both my moral and economic beliefs. To show why it does
so, and why I nonetheless reject it, I will discuss a case in which
the claim seems at first very plausible.

Suppose there is some individual who requires--and
does not get--a ten million dollar operation to save his life.
Further suppose that ten million dollars is precisely the sum spent,
during a year, by all the people in the U.S. in order to have mint
flavor in their toothpaste. Surely this is a monstrous outcome--a man
losing his life in order that others can have the trivial pleasure of
mint flavor in their toothpaste.

The conclusion seems unavoidable, but I believe it
is wrong. The problem, I think, is a fault in my (and I presume your)
moral intuition--our inability to multiply by large numbers. To most
of us, a number such as two hundred million has only a vague
meaning--we have no intuition for how much the importance of a
trivial pleasure is increased when it is multiplied by two hundred
million. In contemplating the situation I have described, we end up
comparing the value of one life to the value of a trivial pleasure to
one person, or perhaps a few. Seen that way, the answer appears
obvious.

In trying to test my intuition, I find it useful
to remove the other people from the problem and convert numbers into
probabilities. Suppose I know that by eliminating mint flavor from my
toothpaste I can avoid a one in 200 million chance of my own death.
That is, in some sense, an equivalent problem--at least if we
specify, in the first situation, that nobody knows whether or not he
will be the one in need of medical treatment.

Put this way, the answer is far from obvious; this
time it is the tiny probability that my intuition finds it difficult
to deal with. In order to help it out, I imagine that I get to make
the same choice two hundred times, each time eliminating some minor
pleasure. It seems far from clear that giving up two hundred minor
pleasures--mint flavored toothpaste, the availability of my favorite
flavor of ice cream, lying in bed an extra minute each morning,
rereading a favorite book one more time--in order to eliminate a one
in a million chance of dying is a good deal.

As a further crutch to my intuition, I try
converting one chance in two hundred million of losing all of my life
into a certainty of losing one two hundred millionth of my life;
while there is no obvious reason why I must be risk neutral with
regard to years of life, it seems the natural first approximation.
Assuming that I have fifty more years to live, one two hundred
millionth of my life is about eight seconds. That is not an obviously
exorbitant price for mint flavor in my toothpaste.

Rights to Life and Similar Claims

A variety of different arguments are used by
philosophers to defend the proposition that medical care has a
special moral status and that choices involving it cannot be properly
made on the same basis as most other choices. I have neither the
space nor the competence to explore all of these claims, but I will
briefly discuss three--the attempt to derive a right to medical care
from a right to life, the claim that medical care involves objective
needs and hence that the correct amount of medical care is not an
economic issue, and the claim that medical care has a special status
because of its connection with the ability to make choices in the
future.

It is sometimes claimed that individuals have a
self-evident right to life, hence to that necessary to life, hence to
medical care. One difficulty with this argument is that it proves too
much. Medical care is not the only thing whose consumption affects
life expectancy. Nutrition, clothing, housing, education--a very
large fraction of all desirable things have some effect on how long
one lives. If a right to life means a right to anything that
increases life expectancy, then we each have a right to most of what
everyone else possesses--since many of those goods, like medical
care, continue to increase life expectancy at levels of consumption
well beyond their current average.

One possible reply would be that there is a
fundamental difference between denying someone a kidney machine,
hence killing him with certainty, and denying him the additional
amenities that would increase his life expectancy by a few days. I
find this argument unconvincing. A kidney machine does not, after
all, prevent death--it only postpones it. Nothing, so far as we know,
prevents death. It is hard to see any profound difference between
giving someone an additional five years with certainty and increasing
by ten percent his chance of an additional fifty years.

My own view is that to talk of a right to life in
this sense is already a mistake, even before it is translated into a
right to medical care. A right to have life is by its nature
contradictory. The concept of a right to life makes sense as my right
to have other people not kill me. It does not make sense as a blank
check against the rest of the human race for anything that extends my
life.

A second argument for the special status of
medical care holds that economic considerations are appropriate for
choices that involve differing tastes, but inappropriate for choices
where the right answer is a matter of objective fact. Thus, it could
be claimed, one may properly decide who gets a piece of land by who
is willing to offer more for it, but one should not decide who wins a
lawsuit, or which scientific theory is true, by how much each party
is willing to offer the judge. In the first case, the question being
decided is one of value; in the second, it is one of truth.

The problem with this argument is that decisions
about medical care, like most decisions human beings make, involve
issues of both fact and value. When I buy a steak at the grocery
store, my decision depends both on what I think the characteristics
of the steak are and how I value them. Precisely the same is true of
medical care. The expert can provide information about the chance
that an operation will save the patient's life, or about possible
side effects of a drug. But the information does not by itself compel
a conclusion. The patient may care or not care about particular side
effects, value his life more or less in comparison to monetary or
non-monetary costs of the operation, and so on.

A final argument goes roughly as follows. It is
said that there is something peculiarly important--essentially
human--about the ability to make choices. One consequence of lack of
medical care may be a drastic reduction in the number of available
alternatives--a cripple cannot become an athlete, to take a
particularly sharp example. Hence, it is said, while poor people may
not have any general right to be given money, they do have a right to
be provided with medical care. It is claimed that this argument
justifies medical vouchers--payments to the poor that can only be
used for medical expenses.

There are some obvious problems with this. Just as
in the first case discussed, the argument proves too much--many
inputs other than medical care affect our future choices. Further,
the argument for vouchers appears to contain a simple error of
logic--the proposal to increase choice in fact reduces it.

To see why, consider, not the issue of whether
poor people with medical needs should be given money, but the
question of whether, if they are given money, they should be
compelled to spend it on medical care. The claim is that they should.
The argument is that our objective is to increase the range of choice
available to the recipient, that spending money on an operation does
that while spending it on a vacation does not.

There is only one unambiguous sense in which
choices can be increased--if the new set of alternatives includes the
old, plus at least one additional alternative. In this sense,
removing the requirement that the money be spent on medical care
obviously increases choice. The individual who must spend the money
on medical care is free to choose among alternatives A-M--all the
things he can accomplish if healthy. The individual who can choose
how to spend the money can also choose A-M, by spending the money on
medical care, but has additional choices N-Z. It is hard to see how
the former can be said to have a wider range of choice than the
latter. Of course, after spending the money, on either a vacation or
medical care, the individual has reduced his choices--but that is the
usual consequence of choosing.

In ending this part of the essay, I should perhaps
apologize to the philosophers among my readers for trespassing on
their domain. I will refrain from doing so, on the grounds that many
of the arguments propounded by philosophers trespass on territory
that properly belongs to economics. Instead, I invite the
philosophers to correct my errors in their field, as I attempt to
correct theirs in mine.

IV. TECHNICAL ARGUMENTS

So far, I have discussed--and tried to
establish--the relevance of economics and of economic efficiency to
choice in general and to choices associated with medical care in
particular. In this part of the essay I will consider a variety of
economic arguments that might be used to demonstrate the desirability
of governmental involvement in the production and allocation of
medical care, discussing the different ways in which market
imperfections can be expected to occur in connection with the market
for medical care, and the possible interventions in the market that
might improve the market outcome. In all cases "imperfection" means
"failure to achieve an efficient outcome" and "improve" means "make a
change that produces net benefits" in the sense described in Part
II.

In each case, the discussion contains four parts.
The first is a description of the reason for market failure. The
second is a discussion of the (imperfect) market solutions--the ways
in which the market, while failing to achieve the efficient outcome,
approaches it more closely than a casual consideration of the problem
might suggest. The third step is to discuss the ideal governmental
intervention, the efficient solution that would be imposed by an all
wise and all powerful benevolent despot--a bureaucrat god. The fourth
step is to discuss the consequences of actual governmental
involvement, and their attractiveness relative to the outcome of the
market.

The first and third steps of this process, taken
alone, constitute the traditional theory of regulation--the theory
that regulation consists of government stepping in to correct market
failures. The fourth step is what distinguishes the modern theory of
regulation. Instead of asking what an ideal government could do we
ask what a government, possessing the authority to intervene in
certain ways, will do.

The problems discussed will be grouped according
to the source of the market failure: imperfect information,
asymmetric information, imperfect competition, and
externalities/public good problems.

Imperfect Information

The assumption of perfect information seems most
appropriate for goods that are purchased repeatedly and whose
characteristics are easily observed by the user. If I buy packages of
fruit from a store, I discover whether the fruit at the bottom is
worse than the fruit at the top as soon as I open the package, and I
discover whether the fruit tastes as good as it looks as soon as I
eat it. Since each individual purchase represents a tiny fraction of
my lifetime expenditure on fruit, the cost of shopping around to
determine the quality of fruit offered by different stores is small
compared to the cost and value associated with consumption of fruit,
and can for most purposes be ignored.

Some medical purchases seem to fit this
pattern--cold medicines, for example, are used repeatedly, providing
the customer an opportunity to determine which ones do noticeably
better than others at relieving his symptoms. But the value of a cold
medicine depends only in part on how well it relieves symptoms; other
relevant considerations are its effect on how fast you recover from
the cold and its side effects, if any. Measuring these effects is
difficult both because your health depends on many different factors
and because side effects may be very long term. So the information on
the quality of medicines that we get by consuming them is very
imperfect. The same applies to information on the quality of medical
services that are consumed regularly--such as the services of a
pediatrician patronized by a large family.

For many medical services the situation is far
worse. Few of us break our bones often enough to form a competent
opinion of the skills of those who set them; still fewer are so
unfortunate as to acquire a large sample of the services of
oncologists or brain surgeons. The same is true for our experience
with medicines used for the rarer and more serious ailments. In these
cases we may be poorly informed. If so, our willingness to pay for
drugs or services reflects only very approximately their real value
to us, hence providers of goods and services may find it in their
interest to provide them even when their real benefit is less than
their cost, or not to provide them even when it is greater. In either
case we have an inefficient outcome.

There are a number of market solutions to problems
of this sort. One is to voluntarily shift the decision, and the
associated costs and benefits, to some organization better informed
than the individual consumer. By buying health insurance, for
example, and allowing the insurance company to provide expert advice
on what doctors I should patronize or what drugs I should use, I
transfer the decision to a firm that has better information and more
expertise than I do.

This raises some additional problems associated
with insurance, which will be discussed below. It also raises the
problem of how to decide which insurance company to trust. One
solution is to purchase life and health insurance in the same
package--since the seller then has a strong incentive to keep me
alive, his incentives are at least roughly the same as my own.
Another is to rely on published reports of the performance of
insurance companies. While this again imposes information problems on
the customer, they are less severe than the original problems--there
are fewer insurance companies than doctors, so it is easier to get
some measure of their relative performance.

Another solution is for some expert body to
certify the quality of drugs or physicians; a familiar example in
another field is the Underwriter's Laboratory. In the case of
prescription drugs, and to some degree of non-prescription drugs, the
customer hires the physician to give him expert advice--and the
physician hires the people who produce medical journals. In the case
of physicians, group practice provides one form of certification and
the acceptance of a physician by a hospital provides another. In a
market without governmental licensing of physicians, other forms of
certification, by medical associations, insurance companies, or the
like, would presumably arise, as they have in other
professions.

Another solution is a guarantee. If customers
believe that they are ignorant about the effects of drugs and that
the drug companies are not, they should strongly prefer drugs
produced by companies that assume liability for unexpected side
effects--and be willing to pay more for the drugs sold by such
companies. Under those circumstances, a company's refusal to
guarantee its product is tantamount to an admission that it knows
something the customers do not. Similarly, if patients believe that
physicians vary widely in quality, they may choose to patronize those
who voluntarily make themselves legally responsible for their
errors.

There are two sides to the question of
guarantees--or more generally, of liability. Given that the court
system is costly and imperfect, the cost to a physician of being
liable for his mistakes--or what a court decides are mistakes--may be
larger than the value to his patients of having him so liable. Under
a market system the rule is freedom of contract. The legal system
establishes a default rule--caveat
emptor or caveat
venditor or something in between--and the
physician is free to transfer the liability to himself by offering a
guarantee or away from himself by requiring patients to waive some or
all of their rights to sue in exchange for his treating them. Under
such a system the market differential between "guaranteed" and
"non-guaranteed" physicians, or between the services of the same
physician with or without the guarantee, reflect the cost to the
physician of being liable--the cost of additional malpractice
insurance, lawyer's fees, damage payments, and the like. The customer
is free to decide whether the additional security is worth the
additional price. Under our present system liability rules are
determined by the courts and waivers are unenforceable. The customer
ends up paying for the malpractice insurance whether or not he thinks
it is worth the price.

So far I have discussed private solutions to
problems of imperfect information. What about governmental solutions?
The obvious one is for the government to generate information,
leaving the customer free to decide for himself how to make use of
it. A familiar example is the labeling of cigarettes; the customer is
informed that the government believes they cause cancer, and is free,
if he wishes, to reject the conclusion--or to decide that he is
willing to pay a price in increased cancer risk in exchange for the
pleasure of smoking.

As long as we are dealing with rational--albeit
imperfectly informed--consumers, it is better for the government to
leave the consumer free to utilize the information it provides as he
wishes. Although the government may have superior information about
the side effects of a drug or the consequences of smoking, the
consumer has superior information about his own values--how much he
enjoys smoking, how important side effects are to him, how much he is
willing to pay for a superior product or treatment.

In the case of physicians, this is an argument for
certification and against licensing. An individual who, knowing that
the government believes a practitioner to be insufficiently skilled,
still prefers to go to him--perhaps because he is the only one
available, is less expensive, or speaks the same language as the
customer--is then free to do so. This has the further advantage of
allowing the customer to ignore the government's opinion if he
concludes that it is probably wrong. If his experience with
government generated information is more extensive than his
experience with physicians, he may be able to evaluate the former
even if not the latter.

If we look not at what the government should do to
deal with problems of imperfect information but at what it does do,
we find that certification is an uncommon solution for either
physicians or drugs. Physicians are licensed, and unlicensed
physicians are forbidden to practice. Similarly, although there is
some control over the labelling of drugs, the main effect of
government intervention is to keep drugs off the market until the FDA
has approved them.

One explanation is that present policies assume
customers who are not only poorly informed but irrational as
well--even when the government tells them what they should do, they
refuse to do it. An alternative explanation is that the chief
objective of at least some regulation is the welfare not of the
patient but of the doctor. Whether or not medical licensing improves
the quality of medical care, it surely holds down the number of
physicians and so holds up their salaries. There is extensive
evidence that the American Medical Association has used medical
licensing for this purpose, in some cases supporting requirements,
such as U.S. citizenship, that made more sense as ways of restricting
entry to the profession than as ways of maintaining quality. An in
many cases of licensing--not only of physicians but of barbers,
manicurists, egg graders, yacht salesmen, tree surgeons, potato
growers, and a host of others--it is clear that the political
pressure for licensing came not from the customers but from the
profession.

This raises a general issue frequently ignored by
those who wish to substitute governmental for private decisions. Even
if the government is better informed than the individual, the
individual has one great advantage in making decisions about his own
welfare--he can be trusted to have his welfare as one of his
principal objectives. That is less true of anyone else, including the
set of interacting persons called government.

In the case of FDA regulation of drugs, the
analysis of what happens and why is less clear than in the case of
medical licensing; while it is possible to interpret FDA policy as
the enforcement of a cartel agreement on behalf of the producers of
existing drugs, it may also be interpreted as a response to public
pressure produced by widespread publicity on the hazards of new
drugs, in particular due to the Thalidomide case.

Even if the only interest group affecting the
legislation is the general public acting on free information (because
of rational ignorance, it rarely pays the general public to base its
political decisions on anything else), the results may still be
undesirable, since free information is often not very accurate. If
the FDA licenses a drug that turns out to have disastrous side
effects, the result is a front page story and the end of the career
of whoever made the decision. If it refuses to license a useful drug,
the result is to keep a cure rate from rising--say from 92% to 93%.
The total cost may be very large, but it is not very visible, so the
FDA may have a strong incentive to be overcautious, possibly with
lethal effects.

This point was illustrated some years ago when the
FDA put out a press release confessing to mass murder. That was not,
I should add, the way the press release was phrased, nor the way in
which it was reported. The release announced that the FDA had
approved the use of timolol, a beta-blocker, to prevent recurrences
of heart attacks; it was estimated that its use would save between
seven and ten thousand lives a year.[23] Since beta-blockers were already widely used outside of
the U.S., the FDA was, in effect, confessing that by preventing their
use for over a decade it had killed about a hundred thousand
people--a sizable cost, even when compared to the benefit produced by
the FDA's decision to keep Thalidomide off the market.

Peltzman's study of the effect of the Kefauver
amendments concluded that they had imposed large net costs. So far as
I know nobody has yet done a comparable study attempting to estimate
the net effect, in either dollars or lives, of FDA regulations
restricting the introduction of potentially dangerous drugs. The case
of beta-blockers suggests that it is not obvious whether there has
been a net gain; absent a complete study, it is hard to say much more
than that.

Asymmetric Information

Asymmetric information involves a more subtle kind
of problem, and different solutions, than imperfect information. It
involves situations in which one party to a transaction has
information that the other lacks, and there is no (convincing) way to
share the information with the other party. A standard example is the
used car market.[24] Owners of used cars have information about their quality,
based on experience, that potential buyers cannot reproduce. The
seller can tell the buyer that a particular car is a cream puff
rather than a lemon--but since the seller has an incentive to say
that whether or not it is true, the buyer has no reason to believe
it.

While this is unfortunate for the buyer who ends
up with a lemon, why does it lead to an inefficient outcome? The
problem is that a car may fail to be sold even though it is worth
more to a potential buyer than it is to its present owner. The buyer,
who cannot distinguish good cars from bad, makes an offer based on
the average quality of used cars being sold. The seller accepts or
rejects the offer based on the actual quality of the particular car,
which he knows. In the case of a lemon, the buyer is paying for a
better car than the owner is selling, so he is likely to make an
offer the owner will accept. In the case of a cream puff the reverse
is true; the buyer's offer assumes the car to be average, the seller
knows it is better than average, so he may be unwilling to sell at
any price the buyer is willing to offer. The average car sold is then
worse than the average car offered for sale, since below average cars
are more likely to be sold than above average ones.

That fact further depresses the amount the buyer
is willing to offer--the relevant average for him is the average of
all cars sold, not of all cars offered for sale. The acceptance of
his offer will be evidence that the car is below average. In extreme
cases, this process may proceed so far that only one car is sold--the
worst car on the market, sold at a price correctly reflecting its
quality. In more realistic cases, there is a partial market
failure--some of the better quality cars fail to be sold even though
they are worth more to the potential buyer than to the seller,
because the potential buyer's offer does not take account of their
actual quality.

In the context of health insurance, the same
problem is called adverse selection. Individuals know more about
their own health, past and future, than insurance companies can
learn. An individual's knowledge of how dangerously he drives, how
well he takes care of himself, what medical problems he has been
having that he has not yet reported, how willing he is, if he does
get sick, to sit in the hospital for as long as possible at the
insurance company's expense, and the like, is relevant to how much it
costs to insure him and is inaccessible to the insurance company.
With regard to such information the company must treat each customer
as an average over the population of individuals buying insurance,
and set its rates accordingly. This makes insurance more attractive
for the customer who knows he is a bad risk--more precisely, a worse
risk than the insurance company thinks he is--and less attractive for
the customer who knows he is a better risk than the insurance company
thinks. So the people choosing to buy insurance represent a biased
sample of the population as a whole--a sample biased towards the bad
risks. The insurance company will allow for this in setting its
rates. That makes insurance even less attractive to the good risks,
reducing even further the number of good risks who buy it.

One market solution is a group policy. If an
insurance company insures all the employees of a firm together, the
sample of insured individuals is only slightly biased towards bad
risks, since the existence of the insurance is only a minor factor in
determining who chooses to work for that company. This is an
imperfect solution, since it means that some people get insured who
would not want insurance at a price that correctly reflects their
medical circumstances--individuals whose risk aversion is not
sufficient to make up for the administrative cost of providing the
insurance. It is also imperfect because it applies only to members of
suitable groups.

The obvious governmental solution is a group
policy for the entire population--national health insurance. This
eliminates one of the imperfections of the private solution--its
limited applicability. If provided by a bureaucrat god perfectly
informed about the appropriate level of coverage and all the
associated administrative details, and suitably tailored to the
requirements of different customers, it would be more efficient than
the private alternative.

If we consider the governmental solution under
more realistic assumptions, the case for it becomes far weaker.
National health insurance affects many people other than
patients--and some, such as physicians and hospitals, are more
concentrated and better organized. The arguments of Part II of this
paper suggest that the public good problems associated with providing
"the right amount of health insurance in the right way" may be much
greater than the advantages gained by eliminating adverse selection,
especially given that a good deal of adverse selection can be
eliminated privately by group plans.

In addition to adverse selection, insurance in
general and health insurance in particular involve a second
efficiency problem. While it is due to externalities rather than to
asymmetric information, this seems the most convenient place to
discuss it. The problem is called moral hazard.

Consider an individual deciding whether to stay an
extra day in the hospital. The cost of doing so is $200. The value to
him, in terms of a slight reduction in the chance of a relapse, is
$50. If he is paying his own bills, he goes home. If the insurance
company is paying more than 3/4 of the cost, he stays. Since he is
buying something whose cost is more than its value, the outcome is
inefficient. Put differently, his decision imposes an external cost
on the insurance company; since he ignores that cost in his decision
he may make an inefficient decision. The same problem occurs whenever
the individual either makes decisions affecting benefits he receives
and the insurance company pays for, or makes decisions affecting
costs he pays and benefits that go, at least in part, to the
insurance company. An example of the latter would be an expense--a
medical exam not covered by the insurance, or an improvement in
nutrition--designed to reduce future medical problems.

There are several ways in which the costs of moral
hazard can be reduced. One is coinsurance--if the insured is
responsible for part of the bill, he has at least some incentive to
keep it down. Another is for the insurance company to make some of
the decisions--to pay for only the number of days in hospital that
its doctor recommends, for example.

Moral hazard applies to government health
insurance just as it does to private health insurance--indeed, it
applies to any government program that transfers some of the cost (or
benefit) of individual decisions from the individual concerned to
others. The advantage of the private system is that insurance will
occur only if the gain due to risk sharing (or other advantages) at
least balances the cost imposed by moral hazard--otherwise the
insurance company will find that there is no price it can charge at
which it can both cover its costs and sell insurance. There seems to
be no comparable constraint on the political alternatives. In this
case the market outcome is as good as the best possible political
outcome, and better than any outcome that we would expect the
political system to produce.

Imperfect Competition

One of the assumptions that is usually used in
proving the efficiency of the market outcome is perfect
competition--every consumer and producer is assumed to be a small
enough part of the market so that the amount he consumes or produces
does not affect the price. To see why this matters, consider the
situation of a producer who knows that the higher his rate of output
the lower the market price will be. If he produces at a rate of 101
units a month instead of 100 units a month, his revenue will rise by
the price of one unit and fall by 100 units times the amount of the
resulting price drop. His marginal revenue--the change in revenue due
to one more unit of output--will be the sum of the two changes. Since
his objective is to maximize profit--revenue minus cost--he will
produce up to the point where marginal revenue equals marginal cost.
But it is price, not marginal revenue, that measures the value to a
consumer of one more unit. Units for which the cost of production is
more than marginal cost but less than price will not get produced;
this is inefficient, since it means that there are units not produced
that would be worth more than it would cost to produce them. Similar
problems arise if the assumption of perfect competition is violated
for consumers.

Much of the medical market--most obviously the
services of general practitioners in large cities--has the
characteristics necessary for an almost perfectly competitive market.
The main hindrances to competition on that part of the market are the
result of government interference--the prohibition on advertising the
price of medical services and the restriction on entry to the
profession, both enforced by state regulation of who can practice
medicine. The same applies to the retailing of medicine; advertising
of the prices of prescription drugs has frequently been
illegal.

There is an important point here that I have made
before and will make again. It is not sufficient for the supporters
of intervention in the market to say "we oppose those particular
interventions--what we are in favor of are only the interventions
that increase efficiency." Unless they have some solid theoretical or
empirical grounds for claiming that they know how to achieve that
objective, we must take existing regulation as evidence of what
government does--and will do--given the opportunity. If regulation
has often consisted of the use of government power to drive up the
price of some good or service for the benefit of the producers--and
it has--we must treat that fact not as a repeated accident but as
evidence. That is particularly true if the evidence fits such theory
as we have--and it does. Producers are typically a more concentrated
interest than consumers.

What about imperfect competition resulting from
economies of scale in the medical industry? Examples are drug
research, hospitals, and physicians in sparsely populated areas. In
such cases there exist policies that a bureaucrat god could follow
that would produce improvements. In order to follow the optimal
policies, however, the real world regulator must know the cost curves
of the regulated firms--how much it costs to produce any level of
output, where level includes quality as well as quantity--and the
demand curves of consumers. This is difficult in any industry, and
there is a good deal of evidence that regulation of monopolies does
not and perhaps cannot force them to charge efficient
prices.[25] It is particularly difficult in an industry such as
medicine, where quality variables are important and hard to measure.
Regulation has the additional disadvantage of providing the industry
with a tool that may be used to maintain a monopoly position that
would otherwise be eliminated by technological change; a classic
example is the regulation of canal traffic and trucking by the ICC in
order to defend the railroads from competition.

My own conclusion, considering both the
theoretical arguments and historical experience, is that regulation
of monopolies may never be desirable, and certainly is not in cases
that fall substantially short of complete and very long-lived
monopoly. The question is one on which there is a long literature,
and many economists would take a less extreme position.

Externalities/Public Goods

The final category of market imperfection that I
will discuss is the category of externalities and public goods. I
combine them because they are, to a considerable extent, two ways of
looking at the same problem.

A public good is a good that, if produced, will be
available to all the members of a pre-existing group: the producer
cannot control who gets it. A pure public good is a public good for
which consumption by one individual does not interfere with
consumption by another. The fact that a good happens to be produced
by government does not make it a public good--postal service, for
example, is a private good that happens to be produced by
government--nor does the fact that something is a public good mean
that it cannot be produced privately. Radio and television broadcasts
are pure public goods, yet both are produced privately. The fact that
something is a public good does, however, pose a problem for the
producer who wants to be paid for what he produces--if he cannot
control who gets it, how can he make consumers pay him? This in turn
implies a problem from the standpoint of economic efficiency. If a
good is worth more to the consumers than it costs to produce, it
should be produced; but it will be produced only if the amount the
producer can get paid for producing it is at least as great as his
cost of production. Since the amount that can be raised to pay for a
public good is generally much less than its value to the consumers,
there will be public goods worth producing that do not get
produced--which is inefficient.

One solution to this problem is to have the good
produced by government. This solution, as I pointed out in Part II,
raises a second public good problem. Production of good law--or bad
law for that matter--is a public good from the standpoint of the
group benefitted by the law, so getting the government to do things
requires that someone solve a public good problem.

There are also a number of private solutions to
the public good problem. One is charity. Another is for the producer
to organize a contract among those who will benefit from the public
good by which each agrees to contribute only if the others do. Each
member knows that either his signature has no effect (if someone else
refuses to sign) or it gives him the package "good minus payment" (if
everyone else signs). As long as the specified payment is less than
the value of the good to the consumer, he signs and the good gets
produced.

This solution runs into problems in a world of
imperfect information and non-zero transactions costs, especially if
the public is large. It pays each individual to pretend the good is
of little value to him, or to claim that even though he values it he
is too stubborn to agree to pay for it. If he succeeds in convincing
the entrepreneur drawing up the contract, his name will be omitted
from the list and he will get the public good without having to pay
for it. Such bargaining problems imply that for any save a very small
public, the amount that can be raised to pay for a public good is a
small fraction of its total value--smaller the larger the public. So
methods of this sort can be used only for small publics or for goods
whose cost is small compared to their value.

There are other ways of producing public goods,
including the ingenious solution employed by the broadcast media, but
a discussion of all of them would exceed the bounds of this chapter.
The important results are that public goods can be produced
privately, that the outcome of private production is not in general
efficient (some goods that are worth producing do not get produced),
and that the problems tend to increase with the size of the
group.

An externality is a cost (or benefit) that one
individual's actions impose on another. A public good can be
described as a positive externality, and the prevention of a negative
externality is a public good. As a rule, the term "public good" gets
used to describe situations where the purpose of the action is
producing the good (radio broadcast) and the term "externality" to
describe situations where the action has a separate purpose and the
injury or benefit is a side effect. The line between the two terms is
a blurred one, and the decision of whether to describe a particular
problem in terms of externalities or public goods is to some degree
arbitrary.

The reason that externalities lead to inefficient
outcomes is straightforward. An individual producer produces a good
if and only if the benefit he receives (by selling or consuming it)
is at least as great as the cost he pays. As long as he pays all of
the associated costs and receives all the associated benefits, this
is equivalent to the efficient rule-- "produce if and only if total
benefits are at least equal to total costs." In the case of goods
produced without externalities on a competitive market, the condition
is satisfied; the price he receives equals the marginal value of the
good to the consumer, the prices he pays for his inputs equal their
marginal cost of production, so cost and revenue on his balance
sheets equal the "total social cost" and "total social benefit"
produced by his actions.

With externalities, this is no longer true. Since
the producer pays only part of the cost (or, in the case of positive
externalities, receives only part of the benefit ), the revenue and
cost figures that determine his decision of what and how much to
produce no longer equal the corresponding total values and total
costs. He may choose to produce a good even though total cost
(including the external cost) is greater than total benefit, or
choose not to produce even though total benefit (including the
external benefit) is greater than total cost. The outcome is no
longer in general efficient.

How does all of his apply to the market for
medical care? As on most markets, some of the goods impose
externalities--in the case of medical care, typically positive ones.
If I get inoculated against a contagious disease, that reduces the
chance that I will infect you--a positive externality. If my drug
company discovers a new family of drugs, that provides information
useful to other companies. If I spend money on keeping myself
healthy, that benefits all those who care for me and would be made
unhappy by my illness; it may even benefit people who have never met
me, but feel a glow of pleasant pride at knowing that "My country is
the healthiest in the world" or "year by year the human race is
getting healthier." All of these are properly counted as
externalities. Economic theory suggests that the market will
underproduce inoculations, drug research, and health because in each
case the individual paying the cost receives only part of the
benefit. Similarly, if the use of some antibiotics imposes external
costs by encouraging the development of resistant strains of
bacteria, such antibiotics will be overused, since the individual
using them pays only part of the cost.

All of these, however, are what I earlier
described as mostly private (or at least, largely private) goods. In
each case a large part of the benefit goes to the person who pays for
it--I stay healthy because of my inoculation, the drug company makes
money off its new drugs, and my own health probably gives more
pleasure to me than to even the most altruistic of my friends. If
ninety percent of the benefit goes to me, then I will make the wrong
decision only in those cases where the cost is more than ninety and
less than a hundred percent of the value, so the result, although
inefficient, will not be very inefficient.

I argued in Part II that the political market is
usually very inefficient, since the political pressures for and
against legislation (and other government activities) represent the
values to the groups affected, weighted by their widely varying
ability to exert political influence in defense of their interests.
My conclusion was that the substitution of the political for the
private market was justified, if at all, only in cases of extreme
market failure on the private market. None of the case I have
described involve such extreme failure. I conclude that although the
outcome of the market could be improved by a bureaucrat god, it is
likely to be worsened by real world regulation.

I believe I have now covered all of the obvious
causes of market failure on the market for health care. In most cases
the failure implies that a sufficiently wise, powerful, and
benevolent authority could improve--in terms of economic
efficiency--the outcome of the market. In no case is there any clear
reason to believe that assigning additional power to government--as
government actually exists--would improve the situation; in many
there is reason to believe that doing so would make it worse. In
several cases existing problems are the direct result of government
interference with the market.

Summary

In the course of this essay, I have attempted to
make plausible a thesis many readers will find absurd--that health
care should be provided entirely on the private market, just as shoes
and potato chips are now provided. Obviously I have not, and cannot,
answer all imaginable arguments against doing so; I have tried to
answer the ones I find most persuasive.

One argument that I have not yet answered--and
find very unpersuasive--is the claim that "health is too important to
be left to the market." My response would be that the market is,
generally speaking, the best set of institutions we know of for
producing and distributing things. The more important a good is, the
stronger the argument for having it produced by the market.

Both barbers and physicians are licensed; both
professions have for decades used licensing to keep their numbers
down and their salaries up. Government regulation of barbers makes
haircuts more expensive; one result, presumably, is that we have
fewer haircuts and longer hair. Government regulation of physicians
makes medical care more expensive; one result, presumably, is that we
have less medical care and shorter lives. Given the choice of
deregulating one profession or the other, I would choose the
physicians.

I suggest to those readers who remain entirely
unconvinced that they may be making the error of judging a system by
the comparison between its outcome and the best outcome that can be
described, rather than judging it by a comparison between its outcome
and the outcome that would actually be produced by the best
alternative system available. If, as seems likely, all possible sets
of institutions fall short of producing perfect outcomes, then a
policy of comparing observed outcomes to ideal ones will reject any
existing system.

It is easy, and satisfying, to pick some
unattractive outcome--a poor man, actual or imaginary, turned away
from the expensive private hospital that could have cured his
disease--and describe it as "intolerable," "unacceptable," or some
similar epithet designed to prevent further discussion. This is,
however, a game that any number can play. It is equally easy, as I
demonstrated earlier in this essay, for the defender of the market to
orate about the hundred thousand people who died of heart attacks
because the FDA refused to permit American physicians to prescribe
beta blockers to American patients. In a large and complicated
society, it is likely that any system for producing and allocating
medical care--or doing anything else difficult and important--will
sometimes produce outcomes that can plausibly be labeled as
intolerable.

The question we should ask, and try to answer, is
not what outcome would be ideal but what outcome we can expect from
each of various alternative sets of institutions, and which, from
that limited set of alternatives, we prefer. I have tried to do so.
My conclusion is that there is no good reason to expect governmental
involvement in the medical market, either the extensive involvement
that now exists or the still more extensive involvement that many
advocate, to produce desirable results.

*: This essay originated as a comment on a
manuscript version of Buchanan (1985). My debt to my target, and to
the organizers of the conference at which both papers were given,
will be apparent to anyone familiar with Buchanan's work.